NOTE 11 – DERIVATIVE INSTRUMENTS HEDGING AND NON-HEDGING ACTIVITIES

With effect from January 1, 2015, ASU 2014-11 changed the basis on which we account for repurchase to maturity transactions and linked repurchase financings to be consistent with the basis on which we account for secured borrowings. Accordingly, the assets and repurchase agreements that encompass linked transactions that were previously accounted for on a net basis and recorded as a forward purchase (derivative) contract are now bifurcated, and the gross amounts are reported in available-for-sale securities and repurchase agreements separately. Consequently, our GAAP financial statements as of and for the period ended June 30, 2015 are not directly comparable to prior period GAAP financials.

The Company enters into a variety of derivative instruments in connection with its risk management activities. The Company's primary objective for executing these derivatives and non-derivative instruments is to mitigate the Company's economic exposure to future events that are outside its control. The Company's derivative financial instruments are utilized principally to manage market risk and cash flow volatility associated with interest rate risk (including associated prepayment risk) related to certain assets and liabilities. As part of its risk management activities, the Company may, at times, enter into various forward contracts, including short securities, Agency to-be-announced securities, or TBAs, options, futures, swaps, swaption and caps. In executing on the Company's current risk management strategy, the Company has entered into interest rate swap, swaption agreements, TBA’s and futures contracts. Amounts receivable and payable under interest rate swap agreements are accounted for as unrealized gain (loss) on derivative contracts, net in the condensed consolidated statement of operations. Premiums on swaptions are amortized on a straight line basis between trade date and expiration date and are recognized in the condensed consolidated statement of operations as a realized loss on derivative contracts. In addition, as set out in Note 3, the Company recorded Linked Transactions as a forward purchase (derivative) contract at fair value on the condensed consolidated balance sheet. Although Linked Transactions were accounted for as derivative instruments, they were not entered into as part of the Company’s risk management activities and were not designated as hedging instruments.

The following summarizes the Company's significant asset and liability derivatives, the risk exposure for these derivatives and the Company's risk management activities used to mitigate certain of these risks. While the Company uses derivative instruments to achieve the Company's risk management activities, it is possible that these instruments will not effectively mitigate all or a substantial portion of the Company's market rate risk. In addition, the Company might elect, at times, not to enter into certain hedging arrangements in order to maintain compliance with REIT requirements.

Balance Sheet Presentation

The following tables present the gross fair value and notional amounts of the Company’s derivative financial instruments as of June 30, 2015 and December 31, 2014.

	June 30, 2015
	Derivative Assets				Derivative Liabilities
	Fair value		Notional		Fair value			Notional
Interest rate swaps	$	-		-	$	(2,850,933	)		271,000,000
Futures		-		-		(349,586	)		190,000,000
Total	$	-		-	$	(3,200,519	)		461,000,000

	December 31, 2014
	Derivative Assets				Derivative Liabilities
	Fair value		Notional		Fair value			Notional
Interest rate swaps	$	-		-	$	(1,755,107	)		226,000,000
Swaptions		21,550		25,000,000		-			-
Futures		-		-		(533,951	)		98,000,000
Total	$	21,550		25,000,000	$	(2,289,058	)		324,000,000

The following tables present the average fixed pay rate and average maturity for the Company’s interest rate swaps (excludes interest rate swaptions) as of June 30, 2015 and December 31, 2014:

	June 30, 2015
	Notional		Fair			Fixed Pay			Maturity		Forward
Current Maturity Date	Amount		Value			Rate			Years		Starting
3 years or less	$	35,000,000	$	(110,768	)		0.66	%		0.6		0.0	%
Greater than 3 years and less than 5 years		236,000,000		(2,740,165	)		1.60	%		3.2		0.0	%
Total	$	271,000,000	$	(2,850,933	)		1.48	%		2.9		0.0	%

	December 31, 2014
	Notional		Fair			Fixed Pay			Maturity		Forward
Current Maturity Date	Amount		Value			Rate			Years		Starting
3 years or less	$	35,000,000	$	(124,591	)		0.66	%		1.1		0.0	%
Greater than 3 years and less than 5 years		191,000,000		(1,630,516	)		1.66	%		3.7		0.0	%
Total	$	226,000,000	$	(1,755,107	)		1.51	%		3.3		0.0	%

Offsetting of Financial Assets and Liabilities

The Company’s repurchase agreements are governed by underlying agreements that provide for a right of setoff in the event of default of either counterparty to the agreement. The Company also has in place with its counterparties ISDA Master Agreements (“Master Agreements”) for its derivative contracts. In accordance with the Master Agreements to each counterparty, if on any date amounts would otherwise be payable in the same currency and in respect of the same transaction by each party to the other, then, on such date, each party’s obligation to make payment of any such amount will be automatically satisfied and discharged and, if the aggregate amount that would otherwise have been payable by one party exceeds the aggregate amount that would otherwise have been payable by the other party, replaced by an obligation upon the party by whom the larger aggregate amount would have been payable to pay to the other party the excess of the larger aggregate amount over the smaller aggregate amount. The Company has pledged financial collateral as restricted cash to its counterparties for its derivative contracts and repurchase agreements. See Note 2 for specific details on the terms of restricted cash with counterparties and Note 9 for the amounts of restricted cash outstanding.

Under GAAP, if the Company has a valid right of setoff, it may offset the related asset and liability and report the net amount. The Company presents repurchase agreements subject to Master Agreements or similar agreements on a gross basis, and derivative assets and liabilities subject to such arrangements on a net basis, based on derivative type and counterparty, in its condensed consolidated balance sheets. Separately, the company presents cash collateral subject to such arrangements on a net basis, based on counterparty, in its condensed consolidated balance sheets. However, the Company does not offset financial assets and liabilities with the associated cash collateral on its condensed consolidated balance sheets.

The below tables provide a reconciliation of these assets and liabilities that are subject to Master Agreements or similar agreements and can be potentially offset on the Company’s condensed consolidated balance sheets as of June 30, 2015 and December 31, 2014:

	June 30, 2015
									Gross amounts not offset
						Net amounts			in the Balance Sheet ⁽¹⁾
	Gross amounts			Gross amounts		of liabilities					Cash collateral
	of recognized			offset in the		presented in the			Financial		(Received)/		Net
Description	liabilities			Balance Sheet		Balance Sheet			instruments		Pledged		amount
Repurchase agreements	$	541,041,099		$	-	$	541,041,099		$	-	$	-	$	541,041,099
Interest rate swaps		(2,850,933	)		-		(2,850,933	)		-		2,850,933		-
Futures		(349,586	)		-		(349,586	)		-		349,586		-
FHLB Advances		53,400,000			-		53,400,000							53,400,000
Total	$	591,240,580		$	-	$	591,240,580		$	-	$	3,200,519	$	594,441,099

	December 31, 2014
								Gross amounts not offset
						Net amounts		in the Balance Sheet ⁽¹⁾
	Gross amounts		Gross amounts			of assets					Cash collateral
	of recognized		offset in the			presented in the		Financial			(Received)/		Net
Description	assets		Balance Sheet			Balance Sheet		instruments			Pledged		amount
Linked transactions⁽²⁾	$	210,402,629	$	(149,584,518	)	$	60,818,111	$	(60,818,111	)	$	-	$	-
Swaptions		21,550		-			21,550		-			-		21,550
Total	$	210,424,179	$	(149,584,518	)	$	60,839,661	$	(60,818,111	)	$	-	$	21,550

	December 31, 2014
									Gross amounts not offset
						Net amounts			in the Balance Sheet ⁽¹⁾
	Gross amounts			Gross amounts		of liabilities					Cash collateral
	of recognized			offset in the		presented in the			Financial		(Received)/		Net
Description	liabilities			Balance Sheet		Balance Sheet			instruments		Pledged		amount
Repurchase agreements	$	594,877,852		$	-	$	594,877,852		$	-	$	-	$	594,877,852
Linked transactions⁽²⁾		(149,584,518	)		149,584,518		-			-		-		-
Interest rate swaps		(1,755,107	)		-		(1,755,107	)		-		1,755,107		-
Futures		(533,951	)		-		(533,951	)		-		533,951		-
Total	$	443,004,276		$	149,584,518	$	592,588,794		$	-	$	2,289,058	$	594,877,852

(1) Amounts presented are limited in total to the net amount of assets or liabilities presented in the condensed consolidated balance sheets by instrument. Excess cash collateral or financial assets that are pledged to counterparties may exceed the financial liabilities subject to Master Agreements or similar agreements, or counterparties may have pledged excess cash collateral to the Company that exceed the corresponding financial assets. These excess amounts are excluded from the tables above.

(2) Non-Agency RMBS and Multi-Family MBS securities within a Linked Transaction serve as collateral for the Linked Transaction. See Note 3 “Non-Hedging Activity – Linked Transactions” for information on Linked Transactions.

Income Statement Presentation

The Company has not applied hedge accounting to its current derivative portfolio held to mitigate the interest rate risk associated with its debt portfolio. As a result, the Company is subject to volatility in its earnings due to movement in the unrealized gains and losses associated with its interest rate swaps, swaptions and any other derivative instruments.

The following table summarizes the underlying hedged risks and the amount of gains and losses on derivative instruments reported net in the condensed consolidated statement of operations as realized gain (loss) on derivative contracts, net and unrealized gain (loss) on derivative contracts, net for the three months ended June 30, 2015 and June 30, 2014 and six months ended June 30, 2015 and June 30, 2014:

	Three Months Ended June 30, 2015
	Amount of realized			Amount of unrealized
Primary underlying risk		gain (loss)			appreciation (depreciation)		Total

Interest rate:
Interest rate swaps	$	(900,671	)	$	776,847	$	(123,824	)
Futures		(316,721	)		125,185		(191,536	)
Total	$	(1,217,392	)	$	902,032	$	(315,360	)

	Three Months Ended June 30, 2014
	Amount of realized			Amount of unrealized
Primary underlying risk	gain (loss)			appreciation (depreciation)			Total

Interest rate:
Interest rate swaps	$	(765,826	)	$	(4,807,659	)	$	(5,573,485	)
Swaptions		(84,000	)		(467,598	)		(551,598	)
Futures		-			(693,285	)		(693,285	)
Total	$	(849,826	)	$	(5,968,542	)	$	(6,818,368	)

(1) In the three month period ended June 30, 2015, net swap interest expense totaled $719,442 comprised of $900,215 in interest expense paid (included in realized gain (loss) and $180,772 in accrued interest income (included in unrealized appreciation (depreciation). In the three month period ended June, 2014, net swap interest expense totaled $679,777 comprised of $765,826 in interest expense paid (included in realized gain (loss) and $86,049 in accrued interest income (included in unrealized appreciation (depreciation).

	Six Months Ended June 30, 2015
	Amount of realized			Amount of unrealized
Primary underlying risk	gain (loss)			appreciation (depreciation)			Total

Interest rate:
Interest rate swaps	$	(1,421,593	)	$	(1,095,827	)	$	(2,517,420	)
Swaptions		(84,000	)		62,450			(21,550	)
Futures		(2,542,285	)		184,371			(2,357,914	)
Total	$	(4,047,878	)	$	(849,006	)	$	(4,896,884	)

	Six Months Ended June 30, 2014
	Amount of realized			Amount of unrealized
Primary underlying risk	gain (loss)			appreciation (depreciation)			Total

Interest rate:
Interest rate swaps	$	(1,142,140	)	$	(9,036,957	)	$	(10,179,097	)
Swaptions		(168,000	)		(1,148,003	)		(1,316,003	)
Futures		(191,047	)		(847,550	)		(1,038,597	)
TBAs		(191,406	)		(68,359	)		(259,765	)
Total	$	(1,692,593	)	$	(11,100,869	)	$	(12,793,462	)

(1) In the six month period ended June 30, 2015, net swap interest expense totaled $1,433,547 comprised of $1,421,156 in interest expense paid (included in realized gain (loss) and $12,391 in accrued interest expense (included in unrealized appreciation (depreciation). In the six month period ended June, 2014, net swap interest expense totaled $1,316,793 comprised of $1,142,140 in interest expense paid (included in realized gain (loss) and $174,653 in accrued interest expense (included in unrealized appreciation (depreciation).